COST ACCOUNTING – MODULE 3 CONTROL PROCEDURES
SYSTEMS OF ACCOUNTING FOR MATERIALS ISSUED TO PRODUCTION AND
ENDING MATERIALS INVENTORY
Either the periodic inventory system or the perpetual inventory system may
be used to account for materials issued to production and ending materials
inventory.
ACCOUNTING BY THE PERIODIC INVENTORY SYSTEM
Under a periodic inventory system, the purchase of direct and
indirect materials is recorded in an account entitled ‘ Purchases. If a
beginning materials inventory exists , it is recorded in a separate account
entitled ‘ materials inventory beginning plus purchases will be equal to the
materials available for use. Ending materials inventory is determined by a
physical count of the materials on hand at the end of the period. Cost of
materials issued is determined by deducting from the materials available for
use the materials inventory end.
Note that under this method the cost of materials issued is not directly
determined, it is indirectly computed by deducting the remaining inventory
on hand from the total available for use.
ACCOUNTING BY THE PERPETUAL INVENTORY SYSTEM
Under a perpetual inventory system, the purchase of direct and
indirect materials is recorded in an account entitled materials inventory,
rather than in a purchase account. The beginning materials inventory is the
balance of the materials inventory at the end of the previous period. When
materials are issued , the materials inventory account is credited for the
cost of direct materials with a corresponding debit in the work in process
inventory. Issuance of indirect materials is debited to the factory overhead
control account . Under the perpetual inventory system , both the cost of
materials issued and the ending materials inventory can be directly
ascertained after each transactions.
It is of utmost importance that a company has a good system of materials
inventory control. Achievement of good control keeps costs at a minimum
level and plant production on a smooth uninterrupted schedule. The
following concepts should be employed in an inventory control system.
1. Inventory is the result of purchasing raw materials and parts. It is
also the result applying labor and factory overhead to the raw
materials to produce finished goods
2. Reduction of inventory is the result of normal use and also finding
alternative uses for scrapping unneeded items.
3. Optimum inventory investment is based on quantitative
techniques , which are designed to minimize the cost of carrying
inventory and the cost of ordering inventory.
4. Efficient purchasing, management and investment in materials
depend on an accurate forecast of sales and resulting production
schedules
5. Forecasts help determine when to order materials . Controlling
inventory can be accomplished by scheduling production.
6. Inventory control is more than maintaining inventory records.
Control is exercised by people who are making personal judgments
partially on the basis of past experiences but within the general
framework of organizational objectives and policies to achieve
them.
7. Methods of inventory will vary depending on the cost of the
material and their importance in the manufacturing procedure.
COMMONLY USED CONTROL PROCEDURES
1. Order cycling
2. Min max method
3. Two bin method
4. Automatic order system
5. ABC Plan
 ORDER CYCLING – method where materials on hand are reviewed
on a regular or periodic cycle like for example 30 days . The cycle length will
differ according to the cycle of materials being reviewed . Essential or
important materials will have a shorter review cycle than less important
items . At the time of review , an order will be placed to bring the inventory
at a desired level. A technique often used for small items is the 90-60-30
days method . When the inventory level drops to a 60 days supply , an order
will be placed for a 30 day supply.
MIN MAX METHOD – this method is based on the assumption that
materials inventory have minimum and maximum levels. Once the specific
minimum and maximum quantities are determined , the minimum quantity
will represent the order point. When the inventory reaches the minimum
level , an order is placed to increase the inventory to the maximum level.
Minimum quantities are usually determined to protect the company against
stock out.
TWO BIN METHOD – this method is used for materials that are
considered inexpensive and or non essential. The advantage of this method
is that it is simple and requires only a minimum of clerical time. Under this,
materials are divided and placed into two separate bins . The quantity of
materials that will be used between the time an order is received and the
next order is placed will be on the first bin. The second bin will contain the
quantity of materials that will be used between the ordering and delivery
plus additional units of safety stock. When the first bin is emptied an order
is placed. The contents of the second bin will contain the quantity of
materials that will be used until the receipt of the shipment .
AUTOMATIC ORDER SYSTEM
- This method is used by most companies that are computerized. An
order is automatically placed when the level of the inventory
reaches a predetermined order point quantity. Perpetual inventory
record cards are maintained which records purchases and issuance
of the specific materials. When the inventory balance is equal to the
predetermined order point quantity an order is placed. With the use
of a computer , it is possible to periodically recomputed the
optimum investment in inventory and thus revise the quantity to be
purchased.
ABC PLAN – method used by companies with a large number of materials ,
each one having a different value. The materials control for a high value
item will naturally be different from the material control for a low value
item. The ABC plan is a systematic way of grouping materials into separate
classification and determining the degree of control that each group
requires. For example , inexpensive or not critical materials maybe
accounted for by using the min max method. For expensive and critical
materials a more sophisticated method, such as the automatic order system
may be used.
MATERIALS CONTROL
There are two basic concepts of materials control
1. Physical control or safeguarding materials
2. Control of the investment in materials
PHYSICAL CONTROL OF MATERIALS
Every business requires a system of internal control that includes
procedures for the safeguarding of assets . Inventories just like cash and
marketable securities , are to be protected from unauthorized use or theft.
Inventories usually represent significant portion of a manufacturer’s current
assets and because of this , materials must be controlled from the time the
order is placed with the vendor until they shipped to customers in the
finished form. In general, effective control of material involves
1. Limited access
2. Segregation of duties
3. Accuracy in recording
Limited access – only authorized personnel should have access to materials
storage area. All issuance of materials for use in production and release of
finished goods for shipment should be properly documented and approved.
Segregation of duties – the following functions should be segregated to
minimize opportunities for misappropriation of inventories – purchasing ,
receiving, storage, use and recording .
Accuracy in recording – inventory records should permit the determination
of inventory quantities on hand upon request , and cost records should
provide the data for the valuation of inventories for the preparation of
financial statements .
The most common methods of costing materials issued and finished goods
sold are;
1. First in, first out
2. Average cost
These methods are related to the flow of costs and not necessarily to the
actual flow of materials or finished goods. If only the materials were
acquired at the same cost all year round, then valuation of materials
inventory and will not be a problem because the value can be computed by
simply multiplying the units on hand and the unit cost. The same can be
used fro the finished goods because if the units were produced at the same
cost all year round, the value at the end of the period can be computed by
multiplying the finished goods on hand by the cost to produce each unit.
The different methods are used because the materials are acquired at
different costs during the year. Average costs for perpetual inventory
system refers to moving average and for periodic system – weighted
average.
MATERIALS ACCOUNTING
1. Discounts – constitute a reduction in the list price
a. Trade discounts – generally give in percentage 15 percent , 20
percent etc. are used to convert single price list into a series of
price lists for different types of middleman. Trade discounts are
recorded on the books because purchases are recorded on the
books because purchases are recorded on the books net of
discount.
ILLUSTRATIVE PROBLEM;
WEST Company buys all of the materials and supplies from the Ocampo
Company and is allowed a trade discount of 10 percent . Purchases during
the month were 400,000 before the discount .
Entry ;
Materials 360,000
Accounts payable 360,000
2. Quantity discounts – represent cost savings for volume purchases.
Like trade discounts , quantity discounts are not given explicit
accounting recognition in the books.
3. Cash discounts – granted to customers to motivate them to pay
promptly.
a. When taken method – purchases and liabilities are recorded at
gross amounts at the time of purchase . The discount is only
recognized when the account is paid within the discount period.
b. When not taken method – purchases and liabilities are recorded at
net at the time of purchase , when payment is made after the lapse
of the discount period. , the discount not availed of is charged to a
purchase discount lost account . It is called when not taken method
because if the account is paid within the discount period. No
purchase discount is recorded and therefore readers of the financial
statements would not know the company has availed of the
discount.
c. When offered method- purchases are recorded at net and the
liability is recorded at gross, the difference charged to an allowance
for purchase discount account. When payment is made after the
lapse of the discount period, the discount not availed of is charged
to the purchase discount lost account
Illustrative problem;
Jose Company purchased materials listed at 40,000 terms 2/15
n/30 on August 1
 Aug. 1 materials 39,200
Assume payments as follows; Allow. For purchase discount 800
Accounts payable 40,000
a. Full payment is made on August 14
b. Full payment is made on August 30 Aug. 14 accounts payable 40,000
Allow. For purchase discount 800
Requirements ; Cash 39,200
Entries to record the purchase and payments assuming
Aug. 30 accounts payable 40,000
1. When taken method is used Purchase discount lost 800
2. When not taken method is used. Allow . for purchase discount 800
3. When offered method is used . Cash 40,000

1. When taken method is used 11. FREIGHT IN

August 1 materials 40,000 1. Direct charging – the freight incurred on the purchase of
Accounts payable 40,000 raw materials is added to the invoice price. The accounts
14 accounts payable 40,000 debited for the freight is materials. The effect is an increase
Purchase discount 800 in the unit cost. If two or more materials are purchased and
Cash 39,200 delivered at the same time , the freight must be allocated
30 accounts payable 40,000 using the following methods.
Cash 40,000
a. Relative peso value method – freight is allocated on the basis of the
2. When not taken method is used peso value of the items purchased. This is used for materials
purchased and expressed in different terms of measurement .
Aug. 01 materials 39,200 b. Relative weight method – freight is allocated on the basis of the
Accounts payable 39,200 weight of the items purchased ,
14 accounts payable 39,200
Cash 39,200 2. Indirect charging – the freight incurred on the purchase of
30 accounts payable 39,200 raw materials is charged to factory overhead control
Purchase discount lost 800 account.
Cash 40,000

3. When offered method is used ;